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June 09, 2014

Why PFM Reforms Often Fail in Developing Countries

Posted by Noel Hepworth1

Public financial management (PFM) procedures and systems that are technically advanced – often copying practices that have been established in developed countries - are constantly being advocated as a solution in developing and transition economy countries. Examples include program and performance budgeting, medium-term expenditure frameworks, financial management and control systems based on COSO2 requirements, accrual accounting, cutting-edge financial management information systems (and derivatives), and even internal audit. Such solutions are often regarded as ends in themselves and that mere adoption will provide the ‘magic bullet’ that is often desperately required. However, the experience of working in countries seeking accession to the European Union, and European neighbourhood countries shows that this is just not true.

One of the main reasons for failure is that technical fixes generally ignore culture and the quality of management.

These advanced PFM procedures were developed by countries with strong democratic traditions, an independent judiciary, a sophisticated and largely independent civil service with a separation of political and administrative decision making, relatively low levels of corruption, little patronage, and alternative employment opportunities for civil servants who disagreed with government policies and attitudes. In such contexts, checks and balances exist as an integral part of public life. These attributes, however, usually took several generations to become fully established. In most developing and transition countries, on the other hand, strong institutions have not yet been developed.

The problems created by a weak enabling environment are further compounded by poor managerial structures and capacity. Advanced techniques of budgeting rely for their effectiveness on the existence of a management culture that is capable of interpreting and utilising the information that becomes available. In advanced countries, decisions are typically delegated to managers at appropriate points in the decision-making chain. Only the most important strategic and administrative decisions are taken by the managers at the very top of the organization.

In many developing and transition countries, however, all decisions, not just the most important decisions, are usually channelled through the ‘top manager’, the head of the organisation, the minister or mayor, who is a politician. Politicians, however, are not elected for their managerial capabilities. They have an entirely different role. By taking every decision and signing every document these ‘top managers’ are led to believe that micro management is the only means of maintaining control of their organisation. The result is ‘delegation upwards’ and as a consequence top managers are chronically overburdened with simple day-to-day issues, and have little space for substantive managerial tasks such as strategic policy development, supervision and control, leadership and communication, not least with their staff. In some cases the ‘top manager’ brings in his or her ‘political friends’ as deputies to share responsibility, but fundamentally these deputies only reinforce the centralized and top-down decision making process.

Advanced PFM techniques require more decision making than traditional arrangements adding to the burden upon those responsible for making decisions. For example, internal financial control systems based on international standards such as COSO involve the identification and management of risk, often requiring considerable technical knowledge and judgement, and require supportive and accountable management arrangements in order to be successfully implemented. Similarly, accrual-based accounting and reporting systems, based upon the IPSASs3, require significant technical accounting judgements and estimates to be made as well as decisions about the range and appropriateness of accounting policies. No single, ‘non-technical’ official can make such decisions with any significant degree of competence. The end result is that many ‘advanced’ PFM techniques are not really applied at all: they become a bureaucratic cosmetic and worse can create an illusion of progress where none in reality exists.

Why are managerial structures so difficult to implement and make work effectively in emerging and developing countries? First, lack of trust often exists between politicians and civil servants and vice versa, as a result of ethnic divisions, uncertainties about political loyalties and professional competence. Second, the lack of separation between the political and administrative landscape amplifies the problem of trust. Third, the more professional becomes the civil service the more difficult it is for public officials to exercise patronage. Finally, robust managerial structures and managerial appointments impact upon the distribution of power within and between organisations. To be effective, managers require the ability to make decisions and to exercise authority. So the ‘reach’ of the top manager becomes less, and more decisions are made for non-political reasons. The end result is unwillingness for countries to accept substantive reform, but cosmetic reform is acceptable, indeed desirable.

A further issue is that advanced PFM techniques require the general raising of financial awareness within an organisation, coupled with an increased capacity for financial analysis. As a result, a traditional bookkeeper, for example, will no longer be able to provide the advanced accounting and analytical skills that are necessary. The information systems need to link money and performance which is a much more complex requirement than the traditional form of ‘control’, namely to ensure that actual expenditure matches the budget. Effective strategic financial planning and cash management is needed to mirror the medium-term focus of a medium term budget framework. As a result, higher level skills and recognition of the status of financial managers (rather than bookkeepers) are necessary to complement the implementation of advanced techniques. In most developing and emerging countries, however, such skills rarely exist and management competencies go unrecognized.

The proper approach to sequencing PFM reform is to start with the basics as advocated by Allen Schick and more recently by Matt Andrews and others. To then take a leap from basic PFM systems to these more advanced techniques without paying attention to the managerial and cultural context is a serious mistake, yet it frequently occurs. Another lesson is that the building of institutions, a solid governance framework and public administration reform are prerequisites for many ‘advanced’ PFM reforms. Experience suggests that, at least for those countries seeking accession to the European Union and European neighbourhood countries, such an approach is essential. Only then will ministers and the most senior officials begin to understand the real implications of the adoption of advanced PFM procedures, and enable their countries to benefit from them.

1 Formerly Director (Chief Executive) of the Chartered Institute of Public Finance and Accountancy (CIPFA) and currently a PFM consultant working mainly for OECD/SIGMA on EU accession and neighbourhood countries

2 COSO: Committee of Sponsoring Organizations of the Treadway Commission as adapted by the International Organisation of Supreme Audit Institutions (INTOSAI) for the public sector.

3 IPSAS: International Public Sector Accounting Standards.

Note: The posts on the IMFPFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.

Comments

A succinctly written overview of a fascinating area. Thanks Noel.

As you rightly highlight the enabling environment is all important if clever technical solutions are to gain traction. And many practitioners will have witnessed first-hand the constipation and inefficiency caused when every decision has to be approved 'at the top'. It's interesting to ponder your insight - how the practice of 'top management control' can dilute the positive impact and inherent checks and balance that exist when decision-making is spread more evenly at lower ranks of management.

Francis Fukuyama talks a lot about the need for strong institutions as a precursor to an effective state. Implicit in this is the need to maintain the divide between the political and the bureaucratic levels and for their respective roles to be respected. He also discusses the need for a break in the bonds of kinship... and systems of patronage. These aspirations are inherently difficult for most societies to achieve as they strike at the core of traditional values.

Despite these challenges, we can observe instances where progress is made incrementally. The promotion of systems of monitoring & evaluation that work with existing PFM data (from traditional cash based accounting systems) and focuses on the nexus with 'performance' is possible. Making this information visible and accessible can stimulate a greater awareness and new behaviour. Like all efforts to promote behavioural change this is a long-run game.